German 10-year yield edges lower after hitting highest since 2014

By Stefano Rebaudo

(Reuters) - Germany's 10-year bond yield edged lower after hitting a near eight-year high on Monday, while Italy's risk premium rose amid rising expectations of future euro zone rate hikes after recent comments from European Central Bank officials.

Hawkish policymaker Robert Holzmann said on Saturday the ECB should raise interest rates three times this year to combat surging inflation.

However, bank President Christine Lagarde reiterated that "adjustments to the key ECB interest rates will take place sometime after the end of net purchases (of government bonds) and will be gradual".

Money markets are pricing in 92 bps of ECB rate hikes by year-end from around 95 bps earlier in the session.

"A new sense of urgency among ECB policymakers to respond to the problem of high inflation can be seen clearly in comments from policymakers, particularly over the course of the last week," said George Buckley, economist at Nomura.

Germany's 10-year government bond yield, the bloc's benchmark, was down 2 basis points (bps) at 1.122%, after hitting its highest since August 2014 at 1.189%.

U.S. Treasury yields provided some downward pressure, with the 10-year falling 1.5 bps to 3.109%.

Italy's 10-year government bond yield was flat at 3.149%, after hitting its highest since November 2018 at 3.232%. The spread between Italian and German 10-year yields rose as high as 206.9 bps, its widest since May 2020.

(Graphic: ITDEyspread, https://fingfx.thomsonreuters.com/gfx/mkt/lbpgnyxkovq/Pasted%20image%201652087115010.png)

Yield spreads between core and periphery have recently widened as hopes for monetary and fiscal support for indebted Southern European countries have faded.

According to ING analysts, "the resumption of supply in shaky market conditions is a prime suspect for the recent move in (euro zone) yields".

"If supply is indeed the reason for the market's angst, the pace of selling will abate mid-week, but that doesn't guarantee a retracement lower in yields," they said in a research note.

Analysts forecast scheduled European government bond supply to be around 22 billion euros from euro zone countries, while the EU will syndicate a New Generation Fund (NGEU) bond.

Focus will also be on the war in Ukraine which will likely dictate the tone of risk appetite for the near future.

Russian chief negotiator Vladimir Medinsky said that peace talks with Ukraine had not stopped and were being held remotely, according to the Interfax news agency.

Investors are awaiting U.S. inflation data for April, which might provide more signals about the future monetary tightening path of the Federal Reserve.

"This week's U.S. inflation report could provide some relief as headline and core inflation are likely to level off," Commerzbank analysts said.

However, "the Fed is unlikely to be impressed by headline inflation still at 8% and core inflation at 6%", they added.

(Reporting by Stefano Rebaudo, editing by Susan Fenton)